Over the weekend, I finally picked up and read Dan Ariely's Predictably Irrational: The Hidden Forces That Shape Our Decisions, an accessible intro to the subject of behavioral economics -- that is, the study of how people behave in the real world and why that varies from the predictions made by classical economic theory (which predicts that people behave rationally and in their own interests). This is a subject I've been very interested in for some years and I'd read and blogged a lot of material about Ariely's work, but somehow never got 'round to reading it for myself.

I'm very glad I did! Ariely's a very engaging writer and a smart social scientist with a knack for illustrating his hypotheses about human behavior through elegant and simple experiments. There's no better time than now to read Predictably Irrational, as Ariely's theories about cheating, incentives, self-fulfilling prophecy, self control, and how we value the things we own versus the things we desire go a long way to explaining the econopocalypse, and also provide an excellent framework for analyzing proposals to get the economy moving again.

For example, Ariely describes a series of experiments that measure work performance among randomly selected groups of people where one group is paid nothing, one group is paid a little, and a third is paid a lot. The group that was paid a little did a little. The group that was paid a lot did a lot. The group that was paid nothing did even more. Ariely and colleagues go on to refine this experiment by changing the reward to gifts (chocolates) instead of money, then to gifts whose value is enumerated ("you will receive a $5 box of Godiva chocolates") and examines how this effects performance. He also examines what happens to performance in situations in which one is at first paid to work, then asked to do the same work again for free.

The results are fascinating, and point to the idea that we work hard for money, and we work hard for social reasons, but that one can short-circuit the other, and lastingly so. He then goes on to explain how companies that ask their employees to work harder for social reasons ("you're part of the team") but dismiss the employees for economic reasons ("we need to cut costs") end up in an impossible place. So do companies that ask customers to come make a purchase as a social transaction ("join the family!") but then treat the transaction after the fact as a purely economic matter ("you should have read the fine-print").

Every chapter works in this vein, and taken as a whole, Predictably Irrational presents a fatal blow to the idea that we can run a system on the assumption that people will take courses of action based on rational calculus, unclouded by cognitive blind-spots that make it practically impossible to find the best course of action.

Of course, this is already an accepted reality of the business-world -- it's why, for example, companies worry that an overly discounted price will reset consumer sentiment about the value of their product. It's why advertisers run "lifestyle" ads that don't feature the product or enumerate its benefits. It's why there are introductory offers that increase in price thereafter. All of these are designed to appeal to emotion, not rational calculus.

But in economics, this irrationality is treated like quantum physics: sure, it's true that this happens on the subatomic scale, but the whole system behaves in a rational, Newtonian fashion and can be treated as such. As Ariely persuasively argues, the economic world is full of a lot more weird, irrational quantum effects than we assume.

As Ariely persuasively argues, the economic world is full of a lot more weird, irrational quantum effects than we assume.

Our current model of economic value has always reminded me a lot of quantum mechanics.

According to modern economic thought, the value of an item or service is the intersection of what the buyer is willing to spend and the seller is willing to accept. But the same item might have different values with different buyers or sellers — or even with the same buyer and seller under different circumstances. If you need a new car, for example, you’re willing to pay some price for it, but you probably wouldn’t be willing to pay the same price for a second car, because your need is already filled.

This means that the value of something exists only at the moment of exchange. It’s a quantity that exists only at the time of measurement, and the act of making that measurement can cause it to have a different value the next time it’s measured. Very reminiscent of Heisenberg’s uncertainty principle.

Of course the market fosters rational behavior. Problem is that everyone’s definition of rational is different. Some, of the social Darwinism persuasion, think it’s entirely rational to make as much money as possible any way they can without regard to consequences; others think we might just want to take the well being of others into account.

The free market does provide incentive to be entrepreneurial, but it makes no distinction between incentive and greed. It absolutely astounds me that anyone who just lived through the last decade (or the Great Depression) would still think the market should be free from regulation or control. Every time we’ve let people get as greedy as they wanted, we get reamed. It’s been the same in every era of history; this is not a new story. The only difference is (for some reason) you don’t see torches and pitchforks.

The economists, or rather the economic poseurs shilling for the rich and for corporations, have confused the hypothesis of rational behavior, which allows us do draw demand curves and do calculations, with a conclusion that is clearly not possible.

On rewards and immorality, see Thorstein Veblen, The Theory of the Leisure Class. A laugh-out-loud funny account of human nature written in complete seriousness. It explains most of politics and what passes for economics in this world of sorrow.

And Adam Smith. “All for ourselves, and nothing for other people, seems, in every age of the world, to have been the vile maxim of the masters of mankind.”

I hold that genuine economics is possible, but there is not room in a comment to explain. There are quite lovely mathematical theories on one side, whose preconditions do not apply in most cases in reality, and there is human irrationality on the other side, as expressed in politics, in economic fraud, in Conspicuous Consumption, in recurring bubble mentalities, and in the Masters of the Universe phenomenon among the rich, who feel themselves to be smarter and more moral than the rest of us. I’m trying to work some of this out on the Earth Treasury Web site and at Daily Kos in the context of programs to end global poverty. It looks promising.

Nonprofit organizations have known for a long time that offering small stipends for volunteer work often backfires. The negative effects of rewards were also described in the 1999 book, Punished by Rewards, by the educator Alfie Kohn. He includes many examples like that of the kindergarteners, rewarded for using markers over crayons, who then refused to use them without the reward. My favorite was the joke about a man who was jeered at by schoolchildren on their way home from school each day. One day he said he’d give them each a quarter if they would come back the next day and do the same thing. They eagerly returned. After about a week of handing out quarters, he said he could only afford a penny but would still appreciate their coming to yell epithets anyway. They all decided that was some form of exploitation and certainly not worth it for a penny.

From time to time my friends or family bring up books like this as evidence that human beings don’t have a good grasp of what is really in their best interests, that a free market is therefore inherently unstable, and (this is the invariable conclusion) that I should rethink my long-held libertarian values and embrace (for example) Canada’s scheme of socialized medicine as morally AND practically superior. Some posters have expressed similar views in this thread.

But looking at what Dan Ariely actually says, I find very little that is novel or that challenges any of my actual beliefs, as opposed to weak stereotypes of them. For example, Ariely says in Chapter 1 that “humans rarely choose things in absolute terms,” that they need a context, a set of alternatives against which a purchase is to be weighed. They choose in terms of their passions and not a strict mathematical estimate of utility. But Vilfredo Pareto said all this a century ago, and while some branches of economics ignore Pareto, many still remember his ideas.

Pareto’s view, while rather dark and cynical at times, seems to me to answer the challenge to the free market very well. Why are regulators and legislators considered exempt from this universal human failing? Or voters? How is the tendency to be manipulated by advertising into buying useless junk somehow worse than the tendency to be manipulated by political rhetoric into funding and imposing useless programs? If human beings are inherently irrational, why would we expect better results from forcing people to behave a certain way than from arranging incentives for them to do so?

No need to be dismal about human nature on that–it’s just harder to express thoughts on an intellectually or emotionally difficult topic. Knee-jerk reactions to that aren’t going to add value, but adding another “squee!” to a cute puppy post is exactly what’s expected, almost always appropriate, and easy.

As a serial non-commenter I can tell you what drives me to read a serious, chewy post that I appreciate and then leave without a word. You see, when I see a substantial post I feel compelled to leave a substantial comment. This takes time. Since I check my feeds during my lunch break-or-equivalent, time is a precious resource and so I just skip to the next story.

I read this book and found it informative, interesting, and overall decent. The only issue I had with it is there just seemed to be way too much tooting of his own horn, so to speak. Every chapter tends to follow a “here’s what *I* expected to happen in this scenario and then *I* did some research and here’s what *I* found in *MY* research that *I* did (with X, Y, and Z too).”

I cannot quantify it but it just seemed a little too self-promotional. That doesn’t take anything away from the veracity of the book; but it is a style issue that I didn’t enjoy.

Another good book that dovetails nicely with “Predictably Irrational” is “How We Decide” by Jonah Lehrer. It goes into the neuroscience of decision-making and I found it an excellent read.

Not that I don’t appreciate the Amazon link since that’s where I order books I am giving as presents (and yes, this one sounds like a good one since lots of examination of how market actors fail to be either rational or fully informed should be an interesting read), but wasn’t Amazon’s punishment for the entire Tor (and higher) de-listing that y’all were switching over to Powells or somesuch?

In the investment world with all the quants ready to jump at a falling leaf I still find there is an enormous amount of inertia. Rockefeller said something to the effect that the time to make money was when there was blood in the streets. Buffet picked up positions in a lot of no-brainer blue chips while everyone else hid in the closet. Mutual funds do dumb things lockstep. I’d like to suggest “The Myth of the Rational Market” by Justin Fox. It’s a good read.

This behavior is actually _quite_ logical. It’s also the dual to a situation presented in Freakonomics. Here, work is being done for one of the following: a nebulous social reward, a small fee, a larger fee, or one followed by the other. In Freakonomics it was a penalty rather than a reward. Parents who left their children too long at a day first faced a social penalty for the abuse of worker time. Eventually a small fee was put in place to further encourage them to come earlier, but it backfired because many parents considered the fee more than fair. When the fee was lifted, the higher rate of tardiness remained.

The key here is that -everything- is a commodity, including social status. In each case, the social value was nebulous, and each actor ascribed his own best-guess value to it. When a fee was put in place of the social reward, the value was more precisely defined (and actually shown to be lower than originally thought by most actors). When the fee is removed, all actors remember the new, more precise value. In the end, that means workers don’t want to work for less than they think they’re worth, and parents treat the removal of the fee as a good deal (a service that once was reasonably priced is now offered for free).

I think archanoid at 4, points to an annoying characteristic in an interesting book–s/he says it has a self-promotional feel. I’d describe the problem as it being that it reads as if his agent told him to write something breezy and at a 9th grade reading level and that that did not come naturally to him. The breeziness does not wipe out the substance, but it adds a lot of filler that I really wish weren’t there.

On one level ‘disproving’ the rational consumer “hypothesis” is besides the point – it’s not a scientific proposition, it’s a faith-based assertion that will be treated as true no matter how much evidence is heaped up against it and at that, in spite of its self-evident ridiculousness, because people in positions of power require it to be true to uphold their power and excuse their abuses thereof.

I’ve always been interested in learning the neurology and psychology behind motivation (Carol Dweck, Dan Pink, Heath & Heath), which led me to discover more about the scientific work studying happiness (Dan Gilbert, Gretchen Rubin) and morality (Joshua Greene, Jonathan Haidt), which in turn has led me to try and explore the latest studies and models about decision-making (AntÃ³nio DamÃ¡sio, Barry Schwartz, Michael Resnik). This book fits very well into where I am on my reading about these topics. Thanks for the recommendation! (Thanks also to archanoid for “How We Decide”, I’ll check that one out as well).

It’s certainly valuable contribution to economists but it’s not mind-blowing stuff for the rest of us. I’m not particularly sure why it’s becoming popular just now among some economists to suppose that people aren’t rational, when this is something that psychologists, philosophers and political scientists have known all along. Perhaps because someone was waiting for controlled experiments? Maybe my background as a political economist leads me to see this as all a bit self-evident.

End of the “rational market”? Why not take the next step and suppose that enterprises don’t behave the way economists would like them to either. Enterprises, in fact, don’t play nice and stick to the rulebook. They ‘game’ the system. They’ll willingly subvert a level playing field any way they can; through buying off politicians for preferential laws; by combining and buying into creating multinationals bigger than many countries; by undermining laws to protect the health and well-being of citizens; by getting absurd patent and intellectual property rights to stifle innovation; and so on. You could argue it is immanently rational of corporations to subvert the system for their own gain. You could also argue that it would be quite irrational for them not to try to change the rules in their favour when their is so little blowback when they do. If it adds to the profit margin, who cares if it breaks economic theory?

The myth of rational consumption is one of the biggest lies to be successfully sold to the modern world.

We are making supposedly rational and self-interested decisions in every waking moment. This suggests then that there is a cold, quite detached weighing up of the proâ€™s and conâ€™s before all choices. It exists in the mind of a drunken man, or a psychotic killer, or a hormonal teenager, in a hateful army Lieutenant, or in a neurotic housewife. It must be there in the gambling addict, too. Before he or she spends them self into complete poverty, maybe they can be consoled with the thought that at least it is in their self-interest. The economic rationalist textbooks say so, anyway.

In this article I acknowledge my own guilt of once being an advocate of free market forces.

heh, thanks, now i managed to remind myself that on the one hand the economists talk about rational consumers. On the other hand marketing makes use of every tool of psychology to bypass said rational mind and talk to the lizard inside. And the lizard is winning…

I really liked that book too, but it fails in one important point: the author never defines rationality.

All the behaviors depicted are quite interesting, but they are not that surprising. I’m not sure why Ariely is surprised.
My guess is that he is influenced by neoclassical economics, which make some unrealistic assumptions about human behavior. Then, of course, any divergence from this expectation is considered “irrational”.

If all human behavior is by definition rational, then you have, at best, redefined the word ‘rational’ into meaninglessness. The statement ‘humans are rational’ is then not even wrong because it is non-falsifiable.

At worst, you stand to draw a lot of bad or incorrect conclusions by falsely applying the more common meaning of ‘rational’ (i.e., logical, carefully considered, objective) into your now-tautological statement ‘humans behave rationally’.

Yes, the Austrian definition of rationality is tautological.
At least it is _some_ definition of the word (as opposed to other kinds of economists). Really the concept of rationality does not inform much. It misleads neoclassical economists into expecting some idealized and unrealistic behavior, which then prompts behavioral economists (like Ariely) to point out the flaws in that assumption.

What really matters is that men act (see Mises’s “action axiom”).
The knowledge that men act imply insatisfaction, goals, purpose, means, scarcity, subjective value, choice, preference, etc., and can be used to logically derive a full-fledged and consistent economic theory.

what’s the definition of a rational actor/decision in economics
I post this question to economists.

I though it means that the actor has goals and makes decision by logically analyzing information he/she has as well as considering any missing information.

is that correct?

I think most of these books/talks/experiments illustrates that people can make mistake calculating/analyzing pros/cons, etc. if that’s the case then, I think to develop theories of a market with rational actors is mostly fictional.